Gaining tax benefits

Retirement accounts should be called “tax-reduction accounts” — if they
were, people may be more motivated to contribute to them. Contributions
to these plans are generally deductible on both your federal and state taxes.
Suppose that you pay about 35 percent between federal and state income
taxes on your last dollars of income. (See the section “Determining your tax
bracket” later in this chapter.) With most of the retirement accounts that I
describe in this chapter, you can save yourself about $350 in taxes for every
$1,000 that you contribute in the year that you make your contribution.

After your money is in a retirement account, any interest, dividends, and
appreciation grow inside the account without taxation. With most retirement
accounts, you defer taxes on all the accumulating gains and profits until you
withdraw your money down the road, which you can do without penalty after
age 591⁄2. In the meantime, more of your money works for you over a long
period of time. In some cases, such as with the Roth IRAs described later in
this chapter, withdrawals are tax free, too.
The good, old U.S. government now provides a tax credit for lower-income
earners who contribute up to $2,000 into retirement accounts. The maximum
credit of 50 percent applies to the first $2,000 contributed for single taxpayers with an adjusted gross income (AGI) of no more than $17,000 and married couples filing jointly with an AGI of $34,000 or less. Singles with an AGI
of between $17,000 and $18,250 and married couples with an AGI between
$34,000 and $36,500 are eligible for a 20 percent tax credit. Single taxpayers
with an AGI of more than $18,250 but no more than $28,250 and married couples with an AGI between $36,500 and $56,500 can get a 10 percent tax credit.